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Italy PM vows stability as shares dive on vote fears

Prime Minister Mario Monti promised that Italy's next government would be pro-European as financial markets plunged and EU leaders called for stability after the caretaker leader announced that he will step down ahead of a general election.

"I am very confident that ... whatever coalition or government there will be, will be a highly responsible, Europe-oriented government," Monti said on the sidelines of a ceremony in Norway awarding the Nobel Peace Prize to the EU.

"The markets should not fear a decision-making vacuum" ahead of the elections, he said, warning however that there was a "risk" of populism in the upcoming campaign.

Stocks in Milan closed down 2.2 per cent, and the spread between the yields on Italian and German sovereign bonds widened to more than 360 basis points - a key measure of investor skittishness.

Berlusconi's announcement and his anti-austerity, anti-Germany drive have fuelled concerns, even though polls indicate the three-time prime minister will lose the upcoming general election to centre-left leader Pier Luigi Bersani.

The slump on the markets had a knock-on effect for other vulnerable eurozone economies, with Spanish Economy Minister Luis de Guindos warning that the "doubts" in Italy were hitting Spain too.

European Commission President Jose Manuel Barroso warned that the upcoming elections should not be an excuse to delay key measures for Italy.

“I hope the election time would not be used to postpone the necessary reforms or even to let those reforms go down, because Italy needs them. There are no quick fixes, there are no magic solutions," he told Italian news channel SkyTG24.

Analysts played down fears of a prolonged financial storm for Italy, however, pointing out that Bersani has promised to stick to Monti's reforms if elected.

Italian bank giant UniCredit said there would be "weakness" on the markets in the short term but it was unperturbed about the longer-term outlook.

The bank said the two most likely election outcomes were either a coalition led by the centre-left Democratic Party or a new Monti government.

Berlusconi's People of Freedom party sparked the political firestorm on Thursday by withdrawing its support in parliament for Monti's government.

Berlusconi then launched his campaign on Saturday, indicating a run against Monti's austerity measures and "diktats" from Germany.

Monti on the same day said he said resign as soon as parliament approves next year's budget, bringing forward the likely date for elections to February.

The budget vote is expected to take place by December 21.

After months on the financial high-wire for Italy in 2011, Monti's arrival in November last year calmed the markets as he embarked on an ambitious agenda of austerity and reforms to boost growth.

The 76-year-old Berlusconi, a three-time prime minister, is running for office for the sixth time in a stormy political career spanning two decades.

He was convicted of tax fraud in October but his one-year prison sentence and five-year ban from public office have been suspended pending an appeal.

Berlusconi is also a defendant in a trial for having sex with an underage 17-year-old prostitute.

Karima El-Mahroug, better known as "Ruby the Heart-stealer" was due in court on Monday as a witness for the defence but failed to show.

Police were ordered to track her down and bring her to court to testify on December 17.

Prosecutor Ilda Boccassini said Berlusconi's defence was creating "a strategy to delay the trial so as to make it through the election campaign."

The Catholic Church, which turned firmly against Berlusconi as the accusations of his "bunga-bunga" sex parties emerged, slammed those who would seek to undo Monti's work over the past year.

"We can't let the sacrifices of a year go to pot. The most astonishing thing is the irresponsibility of those who think of arranging things for themselves while the house is still on fire," Cardinal Angelo Bagnasco, head of the Italian Bishops' Conference, told Corriere.

Monti, a former high-flying European commissioner, was voted in by parliament after Berlusconi was forced out by a rebellion in his ranks.

Supporters say Monti has managed to pull Italy back from the brink of bankruptcy but some of Monti's measures like a new property tax, budget cuts and a reform of pensions have proved deeply unpopular.

The economy has also remained stuck in recession, although the government is forecasting that a gradual recovery will begin some time in the second half of next year.